What's the single biggest impediment for Canadian marijuana stocks? It isn't the retail environment in Canada, which should improve in the near future. No, the biggest issue is that Canadian companies can't expand into the U.S. pot market and retain their listings on the major stock exchanges in Canada and the U.S.
It's a huge problem because the U.S. is home to the largest marijuana market in the world. As long as marijuana remains illegal at the federal level, Canadian companies won't be able to capitalize on the U.S. opportunity except by moving into the hemp market.
That's the conventional wisdom, at least. However, there is an alternative for expanding into the U.S. that could work especially well for the larger Canadian cannabis companies such as Aurora Cannabis (ACB 2.52%) and Canopy Growth (CGC 5.37%).
The REIT path
So what is this great way for Aurora, Canopy, and perhaps some of their peers to move into the lucrative U.S. marijuana market? Form a real estate investment trust (REIT).
Innovative Industrial Properties (IIPR 0.34%) has shown just how successful a cannabis-focused REIT can be. The company reigns as the leader in providing real estate capital to U.S. cannabis operators. IIP buys properties then leases them back to cannabis operators. It's a win-win deal. The cannabis operators receive much-needed cash up front and lower their operating costs, while IIP gets a steady revenue stream with double-digit-percentage annual returns.
Unlike most of the big Canadian companies, IIP is already consistently profitable. The company's revenue is growing much faster than either Aurora's or Canopy Growth's. Unsurprisingly, its stock is also trouncing the performance of most Canadian pot stocks so far this year.
Perhaps most importantly, IIP can operate in the U.S. and still list its shares on the New York Stock Exchange. That's because the company itself isn't violating federal marijuana laws (even though its tenants are.) Forming a cannabis-focused REIT just might be the perfect way for Aurora and Canopy to enter the U.S. marijuana market in the short term while they wait on U.S. federal laws to change in a way that allows them to sell marijuana in the states.
Two degrees of separation
Before he was booted out, former Canopy Growth CEO Bruce Linton mentioned the possibility that Canopy would form a REIT. However, the company hasn't pursued the opportunity following Linton's departure.
Canopy did initiate a deal before Linton was fired, though, that gives the company just two degrees of separation from the U.S. cannabis real estate market. The first degree of separation is Canopy's agreement to buy U.S.-based cannabis operator Acreage Holdings pending changes to U.S. federal marijuana laws. The second degree of separation is that Acreage owns a 20% stake in GreenAcreage Real Estate Corp., a cannabis-focused REIT formed earlier this year.
In October, Acreage and GreenAcreage announced a series of sale and leaseback transactions totaling more than $70 million. Earlier this month, GreenAcreage closed the largest single sale-leaseback deal for the cannabis industry so far, buying an Illinois cannabis property from Cresco Labs and leasing it back to the cannabis operator in a transaction totaling $50 million.
Both Aurora and Canopy have also already spun off investment companies. Aurora spun off Australis Capital in 2018, while Canopy spun off Canopy Rivers the same year. Both Australis and Canopy Rivers are able to invest in U.S. cannabis businesses, although neither is organized as a REIT.
Establishing a cannabis-focused REIT (or acquiring one that already exists) would allow Aurora and Canopy Growth to enter the U.S. marijuana market quickly, legally, and most likely profitably. So why wouldn't the companies take what seems to be a slam-dunk move? Probably the biggest reason is that both Aurora and Canopy Growth are having to watch their capital expenditures closely.
After growing rapidly through a whirlwind spree of acquisitions, Aurora is under the gun to achieve profitability. Even though Canopy Growth still has a big cash stockpile, the source of that cash, Constellation Brands, is tired of Canopy dragging down its financial results. It's not surprising that Constellation's CFO is taking the helm as CEO at Canopy Growth. His top priority will no doubt be to put Canopy on a solid financial footing.
However, I wouldn't rule out the possibility that one of the top Canadian cannabis companies could take the REIT path. It just might be a winning strategy that's too lucrative to ignore.